OCZ Technology: Positioning Ahead Of This Critical Earnings Report

OCZ Technology Group (NASDAQ:OCZ), a leading developer of solid state drive solutions for both consumer and enterprise applications, is set to report its earnings on October 10, 2012. I believe that given the extremely high short interest in the stock, coupled with the stock's high volatility, there will be a large share price movement in either direction following the earnings report.

In this article, I outline the current situation of the company in a timeline of material events leading up to the earnings report, and then summarize the potential catalysts for investors and traders on both the long and short sides as a quick reference. Finally, I give some trading strategies targeted for each type of investor sentiment (bear, direction neutral, bull). For a more detailed analysis of the company's recent developments, I recommend the following, more in-depth pieces:

So, How Was Last Quarter's Report?

OCZ's last several months have been turbulent. The last quarterly report was mixed:

The midpoint of the guided revenue range was $115M, and the company came in at $113.6M, a 54% year-over-year increase.

Despite achieving record bookings of roughly $140M in the previous quarter, the company suffered from a shortage of voltage regulators that hurt realized revenue in the quarter (although the orders were shipped by the conference call).

The company's guided operating expenses came in at $41.3M, significantly above the guided range of $37M - $39M.

Gross margins came in at 25.2%. This was a significant increase from the year-ago period of 20.0%, but fell short of the 100 - 250 basis point per quarter increase that management told investors to expect. The shortfall was allegedly due to the voltage regulator issue.

Guidance came in at $130M - $140M, which ex-CEO Ryan Petersen indicated was "conservative." Note that with the $27M carried over, this was effectively guiding to $103M - $113M, a Q/Q decrease.

Following the report, the company's stock fell over 20%. However, something very interesting happened shortly after the report...

The Buyout Rumor

Just a few weeks after the earnings report, the technology news site Fudzilla published a very interesting piece titled, "Seagate Probing OCZ Acquisition," in which it was claimed that Seagate (NASDAQ:STX) was looking into acquiring OCZ. On the release of this article, the stock gained back nearly all of its losses from the earnings report within a few days. Another article was published by the site Bright Side Of News titled, "Seagate To Complete Acquisition Of OCZ?" in which it was claimed that Seagate would announce an acquisition of OCZ during its earnings call.

The rumors then gained further credibility in light of several facts:

Insider sales had completely stopped around April, which is when the acquisition talks had allegedly begun.

The majority of the company is now owned by institutions (~84%), so they were likely to push for a sale in light of the recent execution blunders and apparent inability to reach profitability.

It would have been a cheap way for Seagate to buy into the SSD space.

A particularly aggressive trader initiating a "backspread" options strategy on the December calls by buying 3000 December 8 calls for $0.25 and selling 1500 December 5 calls for $0.75. The strategy loses money as the stock is between $5-8 and is only profitable above $11 or below $5 (net credit).

Unfortunately for OCZ shareholders, the deal did not happen, and the stock ended up drifting back into the $5-6 range. The stock had settled into a nice trading range until the next piece of news hit...

The Pre-Announcement

On September 5th, OCZ pre-announced a revenue shortfall in the quarter that ended on August 31, 2012. The highlights of the pre-announcement were as follows:

Revenues will come in at $110M - $120M. Given the $27M of carried over bookings, this is effectively $83M - $93M.

The company achieved "record bookings" that, ex-CEO Ryan Petersen noted at the recent dbAccess 2012 conference would "lack credibility" if announced ahead of the earnings report.

The miss was due to a shortage of NAND flash and not due to a demand issue.

Gross margins will take a beating since the company ended up needing to use higher cost, enterprise-grade flash to fill consumer drive orders.

The stock quickly entered a new trading range of $3-4.

How To Position Ahead Of The Earnings Report

There are really only three ways to bet on this (from a short-term trading perspective):

A direction-neutral bet on volatility.

A bullish bet in the hopes of a short squeeze and an eventual resolution of the short-term issues plaguing the company.

A bearish bet on continued weakness and the possibility of bankruptcy.

Option #1 - Bet On Volatility With A Strangle

In order to bet on the volatility, I would recommend an options strangle. The reasoning for betting on volatility is simple: the high short interest will either help a momentum-fueled movement to the downside or a short squeeze of gargantuan proportions in the event of things being "good" or even just "not that bad."

To do this, I'd recommend the following strategy:

Buy the October $4 call (priced at $0.30)

Buy the October $3 put (priced at $0.23)

Maximum Loss: $0.53 if the stock trades between $3 and $4 post-earnings

Maximum Gain: unlimited to the upside, $2.47 on the downside.

Option #2 - Bet On A Squeeze With Calls Or Married Puts

In the event that OCZ's management announces that it has inked a NAND deal, that it is currently seeking "strategic alternatives," or simply that the direction of the business will fundamentally change to focus on higher margin segments of the SSD business (ala Fusion-IO (NYSE:FIO) or STEC (NASDAQ:STEC)), a violent short squeeze could occur. But with this stock, it can't hurt to be safe about it.

A fairly safe strategy is to, instead of buying the stock, buy the $4 October calls for $0.30 (as of last trade). This requires a 24% or better appreciation in the share price in order to become profitable, but the downside is limited to the premium paid for the call.

A more aggressive strategy is to instead buy the stock and then buy the $3 October puts for $0.23. Downside, as of last trade, is $0.70, but the upside is unlimited and the trade becomes profitable past $3.70 rather than $4.30.

Option #3 - Bet On Further Weakness With Puts

In the event that OCZ further misses estimates, runs out of cash, can't tap the credit line, or shows no hope of margin expansion in the medium term, the stock will likely continue to be beaten down.

It is very difficult to short shares of such a highly shorted stock, so the best option is to simply buy the $3.00 October puts for $0.23. A more aggressive trader betting on much longer term weakness or bankruptcy should consider longer dated $3.00 puts, although these come at a fairly significant premium (January puts go for $0.70).

A Final Word Of Caution: Information Leaks

A big problem with the shares of OCZ is that it seems that information has been leaking ahead of the last several material news releases.

Ahead of the July call, the stock managed to drop from $5.99 to $5.45 intra-day, representing a 9% erasure of value before the release of negative news.

It's hard to chalk that up to coincidence as again, ahead of the earnings warn, OCZ's stock dropped from $5.86 to $5.36, a whopping 8.5% before gapping down after the warning was issued.

Conclusion

There is a lot of uncertainty surrounding OCZ and its future, so it pays to be cautious heading into the report. Risk only what you can afford to lose, and understand that this is one of the most highly shorted, highly volatile stocks on the Nasdaq. With so much up in the air, there's no such thing as a "sure play" on either side of the trade.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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